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High Hopes For The Emerging Markets: 2014 Could Be The Year For The African Stocks

With the U.S. markets up 30% in that stellar and historic 2013, the question must be asked: where should smart money go now? It may be a stretch for such heady gains to be repeated in 2014, as a lot of good news has been baked in to equity prices, especially here in the U.S. Investors will have to be ready to put their money to work elsewhere for strong returns, and it makes sense to look at emerging markets for continued outperformance.

Emerging markets are by definition marked by economic and social upheaval. This means that the risks of buying equities are great, and so are the rewards. Headlines are always a factor, via government nationalizations of certain industries, coups d’état, electric power outages, and so on. But it is also not uncommon to see some of the fastest economies growing at high mid single digit rates, which means that business is growing in tandem, and that in turn usually means profits for investors.

The U.S. may have captured the lion’s share of attention in 2013 amid government shutdowns and Fed tapering. But some of the best performing stock markets have been found away from those shores, with Venezuela up more than 450%, and Zambia and Nigeria up in the mid 30%.

Despite the 34% gain in Nigeria’s stock exchange, there have been some indications in recent weeks that further rallies may lie ahead in 2014. The country’s government has been taking a series of encouraging steps to address pressing issues of economic development, national security and business and investment-friendly measures that should help GDP, which has been expanding at an impressive 6%+ pace (annually) keep booming.

One indication of confidence lies with the Nigerian stock market reaction over the past few weeks when the U.S. State Department formally labeled Nigeria’s Boko Haram a terrorist group, in November 2013. But contrary to what might be thought of as “conventional wisdom,” shares on the country’s stock exchange rallied. I’d chalk up the stock market’s surge to investor optimism that Boko Haram will be stopped and that the country’s economy (and its stock market) is in no danger of any sudden, pronounced capital outflow.

Far from spooking global investors, the frank admission that the security situation needs to be addressed has galvanized the Lagos market. The blue-chip Nigerian stock index is up 2.1% since the announcement and the Global X Nigeria ETF (NGE), the most efficient way for U.S. investors to get exposure to Africa’s biggest and most dynamic frontier economy, has rebounded 4.5%.

Boko Haram has been linked to Al Qaeda splinter cells from Algeria in the north through the Sahara and neighboring countries, becoming increasingly violent in attacks on Nigerian Christians and foreign nationals in recent years.

While the Nigerian military has had its share of independent success recently in containing the group in the remote northeast, additional pressure from the United States may accelerate the clean-up process and ultimately put hundreds of thousands of Americans living in the country at ease.

As Nigerian Senate President David Mark has told me, security is a critical factor for the current administration and extremist groups like Boko Haram have already been pushed to the country’s borders. The next step – which now looks like it will be pursued in cooperation with U.S. political leverage and maybe even military support – will be to shut the group down entirely.

So far, the news seems to only be feeding enthusiasm over Nigeria’s booming economy. With a GDP on par with global capital destinations like Hong Kong and Singapore, the country is still in the process of outgrowing its Wild West reputation for both rambunctious growth and a little danger.

But while the entrepreneurial energy of Lagos may remind fund managers of a vibrant growing metropolis, Nigerian stocks still trade at something of a “distress discount” on a variety of metrics. That discount does not reflect the reality of new government initiative to combat lawlessness. That discount also represents opportunity for investors willing to bet on those initiatives. True, the government isn’t perfect, but some of its achievements are laudable, especially in nurturing economic growth.

Enormous potential waiting for a green light

As it is, the $31 billion currently moving on the Nigerian Stock Exchange represents annual economic activity of $268 billion. To buy the same amount of productivity in Singapore, for example, would cost nearly $737 billion, or 23 times as much. Even in relatively mature emerging markets like Brazil and Russia that are unlikely to enjoy much in the way of future growth, domestic equity trades at a 200% to 300% premium over what it would cost in Lagos.

The Nigerian economy is growing at an annualized rate well above 6%, faster than any of the top-tier emerging markets including China itself. Although the oil sector still contributed $8 billion to GDP in the first quarter of 2013 – largely in the form of exports to the United States — the country’s petroleum wealth now takes a back seat to its expanding middle class.

While a planned Beijing-style economy runs counter to all the laissez-faire impulses the oil boom has brought to Lagos, investors here can also count on more transparency and better corporate governance than ever. Interestingly, the Nigerian Stock Exchange said earlier this year that it would partner with the Convention on Business Integrity in order to establish a corporate government index for listed companies in the country offering scorecards on corporate integrity, compliance and reputation.

As corruption recedes, the young and dynamic population is finding work. New infrastructure is coming online to support private enterprise and while oil remains the center of the economy, education, employment, agriculture and even home ownership are rapidly emerging as linchpins of the new Nigeria.

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